Applied Rationality focuses on public policy issues and tries to take a liberal perspective that is consistent (comments to the posts will often show otherwise) with neoclassical, rational-choice economics.

Thursday, October 25, 2007

Rep. Rangel's "mother of all tax reforms"

Rep. Charles Rangel (D-NY) today introduced his long-awaited and mammoth tax reform bill, describing it as "the mother of all tax reforms." Rep. Rangel's bill is a revenue-neutral reform, meaning that cuts and other fixes that reduce the tax receipts going to Uncle Sam are balanced by increases in other areas. Thus, the bill is fiscally responsible--it addresses some problems in the tax code without adding to the federal deficit. However, this also means that the complicated legislation will result in winners and losers.

increasing the refundable part of the child tax credit for low-income households,

extending the coverage and amount of the Earned Income Credit (EIC) for low-income childless households, and

lowering the corporate tax rate.

At the same time, it would increase taxes for others by

adding surtaxes for couples earning more than $200,000 and single filers earning more than $150,000,

taxing "carried interest," mostly earned by investment fund managers, at the same rate as regular income,

eliminating many special tax breaks for corporations, and

changing inventory accounting rules.

By far the biggest changes are the permanent elimination of the AMT and the offseting surtax on upper-income households. The AMT was originally intended as a minimum tax for households with very high incomes that also claimed lots of deductions and would have otherwise paid little if any tax. The AMT is a good idea in principle. However, it has never been indexed for inflation. This has led to "bracket creep" whereby inflation pushed more and more families into the income range where the AMT takes effect. Congress has addressed the problem on a patchwork year-by-year basis but never enacted a permanent reform. Rep. Rangel's bill would simplify the tax code by eliminating this parallel tax system; it would also remove the uncertainty associated with the year-by-year patches.

As currently structured, the AMT brings in an enormous amount of revenue; the projection without any other fixes was $800 billion over the next decade. Eliminating the AMT while remaining revenue-neutral means that all of that money must be replaced. The revenue losses are what have stymied previous reforms. As upper-income households benefit the most from the repeal of the AMT, it makes sense that compensatory, offseting tax increases should be concentrated among them. The proposed surtax is calibrated to match the loss in revenues from the AMT.

Another major component of the reform involves corporate taxes. Tax rates would be lowered, but special deductions would be eliminated and accounting rules would be altered. The net result would be a simplified and more even-handed tax system. This would be devastating to tax accountants. But more importantly, it should remove the government from picking and choosing among special business interests.

It wasn't that long ago that tax simplification was championed by Republicans. Indeed, one of the crowning economic policy achievements of the Reagan administration was the enactment of the bipartisan 1986 Tax Reform Act--a sweeping revenue-neutral package that eliminated deductions, lowered tax rates, and eliminated tax brackets.

Sadly, bipartisanship and budget concerns are absent from today's GOP. The party's spokespeople and special business lobbyists are howling about the necessary offsets and licking their chops at the opportunity to point out all sorts of individual tax increases--without, of course, mentioning that there will be no net change in taxes and that the compensating increases will be concentrated among the very people who benefit the most from the repeal of the AMT. With budget deficits already projected to grow wider over the coming years because of war spending and looming old-age entitlements, the country needs to return to fiscal sanity. Instead, all the Republicans can offer is a bankrupt supply-side fantasy of never-ending (and never paid for) tax cuts.

Because of the herd of oxen that it gores, Rep. Rangel's tax plan has virtually no chance of passing this year or probably next. However, he has offered a sensible, fiscally-sound proposal for finally fixing the AMT and simplifying several parts of the tax code. Maybe there will be an opportunity to return to the bipartisan "spirit of '86."